Research Wire

DO GROWTH STOCKS ULTIMATELY JUSTIFY THEIR PRICE?

Conventional Wall Street wisdom echoes Graham and Dodd, who asserted more than 50 years ago that investors paying more than 20 times average earnings for a stock typically stand to lose considerable money in the long run. But according to Wharton Finance Professor Jeremy J. Siegel, this conventional wisdom is wrong.

In a recently published study in the Journal of Portfolio Management, Siegel analyzed the subsequent returns of the “nifty-fifty,” a group of highly capitalized growth stocks which were touted in the early 1970s, but crashed in the 1973-74 bear market. He found that the long-term performance of these stocks often justified price-to-earnings ratios of 40, 50, or even higher. And, contrary to popular wisdom, these stocks as a whole were not overvalued relative to the market at their 1972 price peak. “Investors should not fear high-cap growth stocks which sell at 30 or more times earnings,” Siegel says. “Many of today’s star performers, such as Coca-Cola, Disney and McDonald’s, were members of the nifty-fifty.”

Jeremy J. Siegel; The Nifty-Fifty Revisited: Do Growth Stocks Ultimately Justify Their Price?

CEOS HIRED FROM OUTSIDE EARN MORE THAN THOSE PROMOTED FROM WITHIN

CEOs hired from the outside earn salaries and bonuses averaging 13 percent more than those promoted from within, a Wharton study has found. And when factors such as firm size, profitability, age, and influence over the board of directors are controlled for, the study found that external successors’ salaries soar to as much as 36 percent more than those of their internally promoted counterparts.

Evidence from a sample of 305 CEOs analyzed for the study validates the hypothesis that external CEOs who lack firm-specific skills earn more than CEOs promoted from within. The study’s authors suggest that in some situations — particularly when there’s a desire to forego the ways of the past — firm-specific skills may even be undesirable.

Dawn Harris and Constance Helfat; Specificity of CEO Human Capital and Compensation

HOW TO GAIN A COMPETITIVE ADVANTAGE IN THE BANKING INDUSTRY

As mergers, downsizing and regulatory changes continue to reshape the banking industry, a new Wharton study has quantitatively identified several areas in which banks can gain competitive advantage: managing risk, increasing customer satisfaction, and exercising prudence in capacity management (for example, adding new branches and new employees).

The study, sponsored by the Wharton Financial Institutions Center, analyzes 219 large banks between 1984 and 1992 and finds that while banks differ widely in their ability to manage risk, large banks take on relatively more risk as measured by the stock market’s assessment of their risk. The study’s author, Gerald R. Faulhaber, also found that if a bank improved its customer satisfaction ranking by 10 percent (based on a nationally-recognized index), it could expect its earnings to increase by 4 to 6 percent. As for expansion, the study found that, on average, banks over-estimated demand by 10 percent, resulting in a 25 percent earnings decrease. “This study shows that the three factors of managing risk, customer satisfaction and capacity management are the keys to competitive success in the banking industry,” Faulhaber said, “Those banks which fail to focus on these areas — and there are many — are leaving money on the table.”

Gerald R. Faulhaber; Banking Markets: Productivity, Risk, and Customer Satisfaction

HOW COMPANIES DETERMINE EXECUTIVE BONUSES

The merit of basing a CEO’s annual bonus contract on the financial performance of a company has long been questioned. But financial performance remains the basis used by the vast majority of firms.

A study conducted by Wharton researchers Christopher Ittner, David Larcker, and Madhav Rajan has found that only 36 percent of firms use alternative performance measures, such as customer satisfaction or product quality, to determine executive bonus pay. Many argue that financial performance-measured bonus pay is detrimental to a firm’s long-run performance, while others consider alternative performance measures subjective and easily manipulated to boost bonuses. Nevertheless, the study finds no evidence of abuse of alternative performance measures. The researchers also found that firms pursuing strategies based on innovation and new product development are most likely to use these alternative measures.

Christopher D. Ittner, David F. Larcker, and Madhav V. Rajan; The Choice of Performance Measures in Annual Bonus Contracts

IN HIGHER EDUCATION, QUALITY PAYS LONG-TERM DIVIDENDS

Attending a higher quality college can increase one’s future wages by as much as 20 percent, according to a study led by Kermit Daniel, assistant professor of public policy and management. The study compared the earnings of men who had similar backgrounds, but who attended colleges of different quality. More than 500 four-year colleges and universities were ranked on a quality scale according to such factors as student-faculty ratio, percentage of faculty with PhDs, and per-student spending rates.

“While there is talk of spending cuts in higher education that would result in lower faculty-to-student ratios and less per-student spending,” Daniel says, “our research suggests that these proposed cuts would have a negative impact on the future wage earnings of college graduates.” The study also found that the wages of black men vary more by quality of college than the wages of whites, while a racially diverse student body increases the earnings of both black and white male students. In addition, the authors, controlling for quality, found no evidence that attending a private university vs. a public university would increase future wages.

Kermit Daniel, Dan Black, and Jeffrey Smith; College Quality and the Wages of Young Men

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